Director compensation has come out of the shadows and is a focus of shareholders, plaintiffs’ lawyers, and shareholder advisory firms. In the December 2017 Investors Bancorp case, the Delaware Supreme Court refused to apply the deferential “business judgment” standard of review to discretionary director compensation awarded pursuant to a shareholder-approved plan. Instead, the court applied an “entire fairness” standard of review. Shareholder litigation with respect to director compensation has subsequently increased, as evidenced by several recent settlements relating to fiduciary breach claims over director compensation. ISS and Glass Lewis review director compensation closely, and ISS announced this spring that it would consider issuing “withhold” recommendations with respect to directors who approve director compensation when there is a pattern of excess director pay without a compelling rationale or other mitigating factors.
In response, some companies are seeking shareholder approval for director compensation programs. Other companies are choosing to retain discretion to set director compensation and are establishing processes to minimize risk. Here are several steps a company can take to avoid a spotlight on director compensation:
1. Establish a Robust Process. Engage a compensation consultant to advise on an appropriate peer group and benchmarking for director compensation. Review benchmarking with respect to total compensation, payment of meeting fees, and stock/cash compensation split. Select a peer group that is appropriate to your company’s size and business, and set director compensation in line with benchmarks. Separate the director compensation decisions from executive compensation decisions, and have the decisions made at separate meetings.
2. Follow Best Practices. Establish stock ownership requirements that are meaningful and consistent with market. Consider holding requirements, under which directors are required to hold shares received from equity grants until retirement from the board, or at least until the stock ownership requirements are met. If any retirement plans or perquisites are being provided to directors, consider discontinuing them. Review any other compensation being provided to directors, and consider the appropriateness of those arrangements.
3. Proxy Disclosure. Clearly describe the process and compensation in the proxy statement.
4. Review your Equity Plan. Despite the Investors Bancorp decision, best practice is to impose a meaningful limit on director compensation in equity plans. Make sure the terms of director grants are consistent with the equity plan (e.g., share limits, vesting provisions).
As if that were not enough: Pennsylvania has recently imposed a requirement that companies withhold Pennsylvania income tax on Pennsylvania-source compensation paid to nonresident independent contractors, including nonemployee directors. This new law will make companies liable for any under-withholding of Pennsylvania income tax on nonresident directors. See our post: New Pennsylvania Nonemployee Income Tax Withholding Deadline. We are working with companies in Pennsylvania to establish processes for determining and reporting nonresident directors’ Pennsylvania-source income. This new Pennsylvania law highlights the importance in all states of nonemployee directors keeping track of their state source income.
Please feel free to reach out to the author or your Morgan Lewis contact to discuss these director compensation issues.